I saw this quote on Twitter and thought I’d post it here. I had no idea who Robert G. Allen is so I looked him up. I usually don’t take to quoting people who write get rich quick self-help types of books but I liked the quote and it gave me the perfect motivation to actually put up a post on my blog.

The retail investment market has really changed since I first started living the business. I consider myself relatively new to the commercial real estate arena, so every day I try to challenge myself to learn, understand, or question something that involves retail commercial RE. It seems over the last year, especially most recently, everyone and their mother is choosing to market their properties with “Best Offer” and no price. Most of the time the same thought always comes to my mind – the seller is not living in reality and wants more than it is worth. By using “Best Offer” the listing broker has a higher probability of investors actually looking at the offering instead of just hitting delete after seeing the CAP rate. Real offers can then be generated, potential bidding wars can be initiated, and the owner can accurately see where the market is speaking. The broker also benefits through the incoming market information of which investors have current exchange/acquisition requirements. That makes sense to me. What doesn’t make sense is when a property that has traveled from brokerage to brokerage priced and continually reduced, is then reintroduced into the market with “Best Offer”. Are they just trying to catch the idiot who wasn’t paying attention to it before? Are they trying to avoid the commonality of current investors who see a list price and offer 50-150 basis points higher? Or are these assets all bank owned, under distress, or soon to be foreclosed? In the beginning the “Best Offer” list price was almost always exclusive to “REO”, “Receivership Sale” or “Bank Owned”, but now there are high credit single tenant investments with the same marketing approach. I kind of get it, nobody wants to show a sub 5% CAP and/or leave money on the table. Since we have never used the “Best Offer” tactic, I’d be really interested to know what other benefits / success stories have came from marketing a property this way.

I consider myself to be fairly competent in matters concerning retail commercial real estate. It is a rare occasion when I am completely unable to grasp even a basic understanding of a concept or characteristic relating to any particular property. Today I find myself in exactly this position. The graph below has me completely bewildered (my markups are in red – click for larger image).

I’m pretty sure the person that made the graph is equally bewildered.

What in the world is this graph intended to say and how does it translate into selling the property in question?

Why do people put information into marketing brochures just to fill space? I can’t see any other purpose for its existence.

I recently received a marketing email for a vacant restaurant building in Las Vegas. The very first “selling point” was as follows:

FDIC Owned!

I see these type of statements all the time now and I just wanted to make a few comments on the matter.

My question is simply this: Why does the ownership of a property constitute a selling point? The simple answer of course is that an REO property is owned by an institution that may not understand true market value or the specific opportunity on the table and therefore price the asset below its true value. I could not disagree with this more.

It seems to me that if the institution hires a broker to handle the disposition, the property should be priced at its highest attainable value, regardless of who owns the property. The broker is supposed to be the market expert and should therefore possess the tools and have the goal of achieving the highest price the market will sustain. If this were the case, there should be no need to advertise distress. The distressed nature of the disposition does not impact the current market value of a property. The property is worth what it is worth, regardless of who is selling it. Advertising distress is like putting a wounded animal out in the forest. All of the vultures are going to come out and attack. It seems to me a broker is hurting the seller by putting the distress at the forefront of the disposition.

This may seem to be trivial point to many of you reading this but I strongly believe that spending time thinking about the psychology behind the marketing and positioning of an asset yields better results for our clients. Too many opportunities come across my desk these days where it appears laziness has ruled the day. Agents take the property information and input it into a brochure template with no thought as to the message or strategy behind the sale of the asset. If you want to lead with “FDIC Owned!” (the exclamation point is especially comical to me) or “Major Price Reduction” (one of my personal favorites) so be it but you may want to consider what the marketplace thinks of those headlines and how they serve to pinpoint your target buyer (hint: they don’t, unless you are trying to help your client leave money on the table).

As it has been stated before, good real estate with solid fundamentals will always garner tenant interest no matter what the market as a whole is experiencing. Below are examples of some larger tenants occupying well located spaces in Orange County that had been recently vacated.

Sears Holdings Corporation has its own website, www.shcrealty.com, dedicated to providing leasing opportunities within their operating locations. You can see the various formats for leasing within their operating stores here.

I just read an article on thestar.com explaining how IKEA is installing solar panels on the roofs of three of their locations in Canada. This is an interesting topic to me as I have had many past discussions with a friend regarding LEED certification of commercial buildings and what advantages retail tenants could gain through green building. I always thought that some of the big box retailers who own their real estate could benefit from installing solar panels on their roofs, but never knew whether or not the end return was large enough to warrant the initial cost. This quote from thestar.com article really caught my attention:

Ikea will generate $684,000 in revenue annually from its previously unused rooftops, from an investment of $4.6 million. The rooftop’s basic costs are already being covered by the retail operation, and fuel costs are as free as the sunshine.

I wouldn’t be surprised if Walmart, Costco, Target and some of the other larger retailers (by square footage) have already installed solar panels on the roofs of some of their locations. If not, I bet they are investigating it. It will be interesting to see what affect (if any) this could have on new leases / future lease extensions between landlords and the above mentioned tenants, especially in the more densely populated urban locations.

Update: Here is another article stating that IKEA is planning to install solar panels at several California locations (Covina, Burbank, Costa Mesa, Emeryville, East Palo Alto and their distribution center in Tejon).

Fresh & Easy has announced that they are closing 13 stores in the Las Vegas (6 closings), Phoenix (6 closings) and Inland Empire (1 closing) markets. This represents about 8% of the 168 total Fresh & Easy stores.

I guess its a good sign that they are willing to pull the plug on underperforming sites rather than let them continue to pile up losses.

I presume most of these sites are leased (as opposed to company owned). If you have ever seen a Fresh & Easy lease or worked on one as an investment you will most likely know that the #1 concern for investors and lenders has always been the financial strength of the entity. US operations were initially funded with approximately $2 Billion but I have yet to see a connection between that $2 Billion and the lease guarantor.

From the way the OC Register article is written, it appears that Fresh & Easy will continue to pay rent and fulfill their obligation as “tenant” under these leases. The first sentence of the article states that “Fresh & Easy is temporarily closing 13 of its “neighborhood” markets in areas that have been hit hardest by the recession.” Stating that these are “temporary” closures indicates that they may desire to open these stores once again. It would be hard to guarantee yourself that option if you default under said leases. Who knows, maybe the locations are bad enough that they can stop paying rent, tell the landlords to pound sand and then come back in 2 years and reopen because the sites are unable to sustain any other retailer. Based upon some of the Fresh & Easy sites I’ve seen, this scenario is not as ridiculous as it sounds.

I would love to see the site closure list. Please send it to me if you have it…..

Update:Here is an article about the Phoenix store closings and here is an article about the Moreno Valley store closing.

I was just looking through the list of the 145 stores in which Blockbuster will be cancelling leases and closing as an initial step in their bankruptcy process. The list shows the monthly rent for each of these locations. A few of the rental figures caught my attention as being inordinately high and I discovered that the three highest monthly rents were found in stores in Los Angeles and Orange County. They are as follows:

Santa Monica: $31,298 / month

Irvine: $27,535 / month

Lake Forest: $21,390 / month

That’s a lot of video rentals and microwave popcorn to sell.

I would be interested to know how much the “elimination” of late fees due to competitive pressures hurt Blockbuster financially. I had heard whispers several years ago that late fees made up something like 30% of store revenues (maybe that info is in their financial reports, who knows).

I am also interested to see what becomes of Blockbuster. I can’t really imagine a world with brick and mortar video rental stores in the age of streaming and on-demand services. Blockbuster has a ton of locations. I really doubt they are going to need most of them. Look for more lease cancellation announcements from Blockbuster in the near future.

I just read an article at GlobeSt.com entitled Fund Steers Small Investors to Triple-Net which covers a new “hedge fund” run by Iridium Capital, a new company based in New York City. I was skeptical about the quality of the so-called “fund” as soon as I started reading the article. It seemed to me like some former broker (in this case a former broker named Marilyn Kane) decided to create a TIC for single-tenant properties and make it seem legitimate and distinguished by calling it a hedge fund. Here we go again.

I am writing this post as a fair warning to anyone considering investing any money in this “fund” (minimum investment is $50,000). This quote from the GlobeSt.com article says all you need to know about why you should not give $0.01 to Iridium Capital (emphasis mine):

The sector in which a triple-net asset resides counts for more than its geographic location, Kane says. “It’s not necessary to go into a depressed area to buy a CVS, but there might be a very good reason that CVS looked into that particular area,” she says. “We have the benefit of getting that information on why they made that choice.”

Are you kidding me? She runs a REAL ESTATE investment “fund”.

It is as simple as this: DO NOT EVER GIVE YOUR MONEY TO SOMEONE FOR THE PURPOSE OF INVESTING IN REAL ESTATE IF THEY BELIEVE THERE IS ANY ONE FACTOR MORE IMPORTANT TO A REAL ESTATE INVESTMENT THAN LOCATION. PERIOD.

Something tells me that the institutional capital she hopes to attract will not materialize. I guess she’ll have to make due with the 2,000 investors at $50,000 each needed to meet her $100,000,000 target. I’m sure they have the infrastructure in place to service 2,000 investors. Yeah right.

This is my first post in a very long time. The only reason I am posting today is because I didn’t really have to do anything to put this post up. The following analysis is from an email I just received breaking down a recently listed retail center. Needless to say, the property is way overpriced and a total piece of junk. So, without further ado, I present you with this back-of-the-napkin breakdown of Victory Plaza in South El Monte, CA (bolded emphasis mine):

Very concerning is in addition to the vacancy and MTM leases another 11,978 sf is expiring in 2012, representing a total of 26,141 sf as possibly vacant or on MTM by 2012. Basically the whole second story could end up being vacant in 2012.

Also the U.S. government occupies 3,600 sf paying $160,404 annually ($3.71 PSF) (30% of Gross income) and expires in 2012. I dunno if i would be very confident that they would resign at that rent when CBRE is quoting market rent for >1,000 sf @ $1.00 PSF and space <1,000 sf at $1.50 PSF. Even if they resigned at half that ($1.85 PSF) that’s about $1,100,000 in lost value @ the 7% CAP.

Crazy that they show market rents as lower than what the actual rent is for the tenants, yet claim in the first few pages that 50% of the center is significantly below market.

I don’t see how someone would pay anywhere over $3M for this deal ($90 PSF), too much risk / uncertainty in the income stream instantly as well as costs associated with stabilization / maintaining occupancy.

I’m not sure how some of my fellow brokers sleep at night knowing they are pawning off this crap on some unsuspecting guy. Whoever buys this property will of course do so with the complete expectation that they will make money. Hopefully he does a Google search for South El Monte first.

How in the world someone convinced a lender to give them an $8.8M loan on this thing is more than baffling.

Side note: I love the depth of the due diligence performed by the marketing team. I have no idea what the total land square footage is but I guarantee you its more than 28,000 square feet. Just more evidence that the brokers play no part in crafting the marketing materials (or really scary if they do). This is also why all the packages look exactly the same and create average results. BigCo CRE Marketing 101: force the deal into the template box rather than rework the template to best position the deal.

Movie Gallery’s Chapter 22 just turned into a 7. The WSJ reports that the firm has decided to shutter all of its 2,415 stores and liquidate completely. Previously, the bankrupt movie rental chain had hoped to continue operating with a trimmed down asset base, and close just half of its stores. Alas, the melting of the ice cube could not be stopped. This is nonetheless good news for liquidating advisor Gordon Brothers which just saw its bill double. As for main competitor Blockbuster, which itself is on the verge of bankruptcy (yes, those still do occur in the US, but the business must be really atrocious plus have no unionized workers anywhere within 50 miles of its operations), it is unclear whether the liquidation of Movie Gallery will be beneficial or merely too late. Tangentially, businesses all over America and the world which otherwise would benefit from the bankruptcy of their weaker competitors and flourish, are suffering just as much, courtesy of the no-risk/no-failure doctrine recently instituted by the administration, which has made Survival of the Fittest irrelevant.

The Wilsonville, Ore., chain had hoped to restructure in bankruptcy court and continue operating around a smaller set of viable stores. The company employed more than 19,000 people when it filed for bankruptcy. Reorganizing around smaller core stores was "honestly debated," said a person familiar with the situation. "It just never got any traction." Movie Gallery, the second-largest movie-rental chain by outlets behind Blockbuster Inc., failed to rebound after it emerged from bankruptcy in spring 2008 owned by private-investment firms Sopris Capital Advisors and Aspen Advisors. Consumers are now viewing movies streamed online or through on-demand cable services. Netflix Inc. has cut into revenues of Movie Gallery and Blockbuster through its mail-order service and online offerings. In addition, movie-watchers have turned to alternatives such as Redbox, a unit of Coinstar Inc. that operates movie-vending machines in grocery stores, among other places. Movie Gallery’s financial woes trace back to debt it took on acquiring Hollywood Entertainment Corp. in 2005. It filed for bankruptcy in February under the weight of roughly $600 million in debt. Blockbuster had weighed acquiring some better-performing Movie Gallery stores, but a deal never gained momentum, said the person familiar with the matter. A Blockbuster spokeswoman didn’t immediately respond to a request for comment. Blockbuster is in the midst of negotiating with bondholders over restructuring debt and warned in a recent regulatory filing that it, too, could be forced to seek bankruptcy protection.

Here is an excerpt from a great comment to the ZH post:

….What I find astonishing is that this particularly train wreck has been coming for some time, but the video superstores continued to blindly believe that their business models were still viable (and are now astonished at how rapidly their businesses are disintegrating under the digital assault).

This is a big bummer for all of the CRE investors who thought it wise to purchase Hollywood Video buildings in outlying areas because they were getting a sliver better return. Stop chasing returns and focus on location. Tenants come and go. They are not making any more dirt.

Is there any question as to the near-term fate of Blockbuster Video? I think not. Its just a matter of how long they can tread water.

I wonder if CoStar has any thoughts on this….

Disclosure: I just sold a single-tenant Blockbuster Video building last week (see here) at a 5.94% CAP in San Jose, CA. Before you accuse me of stuffing some guy in a crappy deal, I’d like to say that the deal was a fair one, the tenant has equity in the lease and numerous other tenants have been contacting us unsolicited for several years to inquire about locating in the building. Again – location, location, location. Tenants don’t cold call landlords unless the site is a good one. Doubtful the owners of the Hollywood Video stores in Lancaster and Palmdale will have a similar experience.

After marketing a what I knew would be a very attractive Southern California single tenant NNN investment for the last week and speaking with many brokers & principals on about the opportunity, it has become readily apparent that a large percentage of the active buyers in today’s market are applying their same arbitrary return hurdle to every deal that comes across their desk. I understand that buyers want to reach a specific return on the equity they are investing, but at what point does this hurdle become a detriment to their investment strategy?

Applying the same CAP rate requirement or return hurdle to any and every deal in the market is like comparing apples to oranges. Sure many deals are going down at 7%+ CAPs, but those deals are either out of state, in secondary markets or have subpar/non-credit tenants. Now obviously we are seeing Walgreen’s deals all over, even in Southern California (one recent example here) ending up in the 7%+ CAP range, but if a buyer is really willing to accept a flat 7.25% return over the course of 25+ years, they should be willing to buy a sub-6% CAP investment with market increases. Over 25 years, the return on an investment purchased at a sub-6% CAP will almost always outperform the flat income stream from Walgreen’s with a starting point at a 7.25% CAP rate. I know that is a very general comparison, but there are plenty of examples of comparable deals where it applies.

The deals in today’s market which are commanding the premium prices are the ones that have one or more of the following attributes:

All of these attributes go hand in hand with each other, so the majority of the time the best deals have all of the listed qualities. What amazes me is many buyers totally forgo demanding the presence of these attributes in the property they purchase in order to achieve a return that is ½% to 1% percent greater. What they are failing to realize is, sure they got their 7% CAP deal, but the rent is probably at or above market and the seller has probably maxed out the value in that investment. The only increase in value they will see is dependent on either scheduled rental increases (and CAP rates not rising) or by having the entire market change and CAP rates dropping across the board. The problem is if CAP rates rise across the market, the investor’s 7% CAP deal is no longer worth what they paid for it (just like all the investors who purchased based on return from 2005-2007). Obviously this would apply to the the alternate investment property I am advocating as well, but the investor who purchased at an aggressive CAP rate but a below market rental rate has a good chance of repositioning their asset in the future to create a much higher value, even in a higher CAP rate environment. The deals that are trading at premium prices and offer the comfort of “no downside risk” will always trade at the premium market prices, even if CAP rates rise dramatically.

The going in CAP rate should not hold the majority weight in every investment decision. The fundamentals of the deal need to be understood and analyzed. Buyers unable to get past their going-in return hurdle may see themselves lose out on some amazing opportunities, or worse, end up in a situation where their investment becomes worth less than they paid.

This is just a quick opinion on the role assumable financing plays in the value of an investment property. It is very interesting that many properties are marketed with the assumable financing being a major benefit, when many times it really is more of a detriment or unattractive. Even worse is that some sellers believe that short term carry at low interest only rates significantly increases their asset’s value.

There are plenty of investments available which tout attractive assumable financing at below market rates. The thought is you are gaining the benefit of a higher cash on cash return (cash flow) then if bought with market financing and as a result, many of these opportunities are offered at very aggressive values. There are two concerns with that line of thought:

1. If I assume a below market rate loan and have to refinance in 5 years, how confident can I be that I will be able to replicate the same or better interest rate and the same amount of debt? In the cases of highly leveraged opportunities, this is even more concerning. Most likely, I will have to accept a lower cash flow since my debt service has increased due to a higher interest rate on my new loan or even worse, I will not even be able to replicate the same amount of debt and have to add more cash to the deal just to refinance. Now I have lower net cash and even more equity in the deal.

2. Many of these assumable loans have maturity dates that do not coincide with the term of the lease or leases. When it’s time to refinance, if there is less than 10 years remaining, it is going to be that much harder to find a lender willing to perform.

Here is a simplified example I came across recently. An owner had a single tenant fast food property in a mediocre location with pretty hefty annual rent and roughly 10 years remaining on the initial term. He said he would like to get a 6 CAP when in reality the market rate for these properties was probably between a 6.75% – 7.25% CAP. To get his price he was willing to carry 4% interest only financing for five years, benefiting the buyer with a low debt service and higher cash flow. Below is the financial example:

Owner Carry

Market Financing

NOI

$175,000

NOI

$175,000

CAP

6%

CAP

6.75%

Purchase Price

$2,916,666

Purchase Price

$2,592,592

Down Pmt

$1,600,000

Down Pmt

$1,600,000

Owner Carry

$1,316,666

Bank Loan

$992,593

LTV

45%

LTV

38%

Interest Rate

4% I/O

Interest Rate

6.75% P/I

Term

5 Years

Term

10 Years

NOI

$175,000

NOI

$175,000

Less Debt Service

($52,666)

Less Debt Service

($82,295)

Cash Flow

$122,334

Cash Flow

$92,704

As you can see the owner carry at the 6 CAP provides $30,000 more in cash flow over the first five years, but requires an additional $325,000 in the form of purchase price. Here is what happens when it is time refinance and make the seller whole. Say interest rates had not got any better or worse and 6.75% is the best that can be done in five years (a very dangerous assumption, by the way), assuming no change in the NOI for all practical purposes.

Owner Carry to Refinance

Market Financing

NOI

$175,000

NOI

$175,000

Purchase CAP

6%

Purchase CAP

6.75%

Purchase Price

$2,916,666

Purchase Price

$2,592,592

Down Pmt

$1,600,000

Down Pmt

$1,600,000

Owner Carry

$1,316,666

Bank Loan

$992,593

New Loan

$1,346,666

LTV

38%

LTV

46%

Interest Rate

6.75% P/I

Interest Rate

6.75% P/I

NOI

$175,000

NOI

$175,000

Less Debt Service

($111,596)

Less Debt Service

($82,295)

New Cash Flow

$63,404

New Cash Flow

$92,704

*All financing besides Owner Carry is based on a 25 year amortization. Owner Carry refinance assumes additional $30,000 in costs for new loan.

Now the cash flow has dropped by $58,930 after refinancing and is $29,300 less than the “Market Financing” option. I personally would rather have paid less in purchase price and have a lower net cash flow then overpay and have the uncertainty as to where my cash flow would be in five years. The reality is that interest rates may be much lower in five years, but they also could be much higher (more likely) and I have no control over that.

Some savvy financial underwriters may argue that the $148,150 in additional cash flow in the first five years resulting from the owner carry ($122,334 – $92,704 = $29,630 X 5 years = $148,150) is better than the $146,500 ($92,704 – $63,404 = $29,300 X 5 years = $146,500) additional cash flow in the second five years with the “Market Financing” scenario. Sure a dollar today is worth more than a dollar tomorrow, but is it a significant difference and is it worth the risk of $325,000 in additional leverage and future interest rate uncertainty? I don’t think so and the buyer pool we are seeing pay the most aggressive prices for these types of assets doesn’t either. They have no interest (or ability) to have their cash flow drop by nearly 50% (or at all) after the first five years. Many are family trusts or conservative individuals who are looking to purchase safe, stable and management free investments from which they can just collect a check every month.